This article was originally published at MF & Co. Asset Management.
Even though penny stocks tend to have much more risk and volatility involved than blue-chip shares, having some exposure to small caps and their potential upside can add strong upside potential for your portfolio.
Penny stocks are more of an American term, referring to stocks that are priced in “pennies”. In Australia, they tend to refer to higher risk stocks with market caps below 500m or so. However, this term is used loosely and can refer to higher risk small-cap stocks.
With the market correction towards the end of 2018, small-cap and growth stocks have been hit hard. With prices much lower than towards the middle of 2018 and valuations well off its highs, there are a lot more opportunities in the market now that you can get set on for the next rally up.
The best small penny stocks to buy now are generally driven by three factors within the markets, understanding these forces helps us time the market and buy or sell small-cap stock at the most opportune moments.
The Three Main Drivers of Penny Stocks
In general, the markets and stocks are firstly driven on a short-term basis via supply and demand imbalances. This is the order flow on a day to day basis as investors buy or sell stock for different reasons. This order flow is generally hard to forecast and requires strong technical analysis and understanding of the underlying market to properly time.
Small cap stocks are particularly hard to forecast on a technical basis. This is because institutional investors tend to stay away from small-cap stocks due to investment mandates and general lack of liquidity. With the lack of institutional investors, small-cap stocks tend to be driven more by rumours and retail investors, which tend to be more emotionally invested in stocks than institutions who tend to trade on logic.
Secondly, markets and stocks are driven by macroeconomic forces in the medium-term. Factors include but are not limited to changes in interest rates, consumer sentiment, government policies and so forth. Understanding the nuances and how the different countries interact with each other in terms of trade and politics is key to understanding the forces that drive the markets as a whole.
Penny stocks tend not to be too highly influenced by macroeconomics and are less correlated to macroeconomic events. This is because small caps tend to be more qualitatively valued rather than quantitatively valued. In other words, small-cap stocks are valued on speculation as to the potential non-existent growth and earnings rather than what they are earning today. However, the macroeconomic environment is still vastly important – understanding what they are selling, who they are selling to and who their established competitors help us understand the potential growth the company has.
Finally, stocks in the long-term are driven by fundamentals. Factors include but are not limited to quantitative factors such as earnings growth, profit margin and return on equity. Qualitative factors include factors such as competition, operating environment, political and policy environment.
Fundamentals are highly important as we make assumptions and valuations based on the environment they will be operating in the future. In unstable or highly regulated environments, understanding the potential pitfalls is the difference between buying a small cap stock with potential and one that is doomed to fail.
To be able to pick the best penny stocks to buy now, it is essential to combine market timing, macroeconomic and fundamental analytics.
Research Is Key To Finding The Best Penny Stocks To Buy Now
The hardest part about investing is the ability to process a large amount of information and factors to be able to navigate the macroeconomic and fundamental environment. Our Research team has been hard at work uncovering the best penny stocks to buy now on the ASX on a macroeconomic and fundamental basis.
On a short-term, market timing basis, this is more tricky and is something that requires patience, skill and experience. Talk to one of our Advisers for more information about how to time entries.
I’ve outlined 5 stocks that we have found to either have good growth potential and a great story and these represent some of the best opportunities the ASX has to offer.
People Infrastructure (ASX PPE) – People Infrastructure Ltd (ASX PPE), a workforce management company, provides contracted staffing and human resources outsourcing services in Australia and New Zealand. PPE is a leader amongst its peers with high growth in profitability and share price. PPE is well positioned to take advantage of the casualisation of the workforce.
Volpara Health Technologies (ASX VHT) – Volpara Health Technologies Ltd (ASX VHT) is a New Zealand-based healthcare research, and development company with global scalability. The company provides medical software, specialising in managing the breast screening detection and the flow of information between doctor clinic taking the screening mammogram x-ray. VHT adoption of the SaaS business model was announced in the recent AGM presentation. The SaaS model has seen revenue increase at an astonishing rate of 1,945%.
Pioneer Credit (ASX PNC) – Pioneer Credit Limited (ASX PNC) is a financial services provider, specialising in acquiring and servicing retail debt portfolios. The company has grown strongly in the past two years and there are no signs that this will slow. PNC has grown 90%+ year on year and outperformed the industry, we expect ASX PNC shares to have a bright future ahead.
Make Your Money Work Harder For You
Picking the best penny stocks to buy now, timing the entry and having an edge in the market is not easy. Download our special report below for another 5 best shares to buy now which comes with an options strategy we use for our clients to generate a consistent return.
Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.